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Now more than ever, a comfortable retirement depends on secure, stable investments. Unfortunately, the right stocks for retirement won't just fall into your lap. Let's figure out what makes a great retirement-oriented stock, then examine whether General Dynamics (NYSE: GD ) has what we're looking for.
The right stocks for retirees
With decades to go before you need to tap your investments, you can take greater risks, weighing the chance of big losses against the potential for mind-blowing returns. But as retirement approaches, you no longer have the luxury of waiting out a downturn.
Sure, you still want good returns, but you also need to manage your risk and protect yourself against bear markets, which can maul your finances at the worst possible time. The right stocks combine both of these elements in a single investment.
When scrutinizing a stock, retirees should look for:
- Size. Most retirees would rather not take a flyer on unproven businesses. Bigger companies may lack their smaller counterparts' growth potential, but they do offer greater security.
- Consistency. While many investors look for fast-growing companies, conservative investors want to see steady, consistent gains in revenue, free cash flow, and other key metrics. Slow growth won't make headlines, but it will help prevent the kind of ugly surprises that suddenly torpedo a stock's share price.
- Stock stability. Conservative retirement investors prefer investments that move less dramatically than typical stocks, and they particularly want to avoid big losses. These investments will give up some gains during bull markets, but they won't fall as far or as fast during bear markets. Beta measures volatility, but we also want a track record of solid performance as well.
- Valuation. No one can afford to pay too much for a stock, even if its prospects are good. Using normalized earnings multiples helps smooth out one-time effects, giving you a longer-term context.
- Dividends. Most of all, retirees look for stocks that can provide income through dividends. Retirees want healthy payouts now and consistent dividend growth over time -- as long as it doesn't jeopardize the company's financial health.
With those factors in mind, let's take a closer look at General Dynamics.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$27.9 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||5 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||4 years||Pass|
|Stock stability||Beta < 0.9||1.24||Fail|
|Worst loss in past five years no greater than 20%||(34.2%)||Fail|
|Valuation||Normalized P/E < 18||12.01||Pass|
|Dividends||Current yield > 2%||2.5%||Pass|
|5-year dividend growth > 10%||15.8%||Pass|
|Streak of dividend increases >= 10 years||20 years||Pass|
|Payout ratio < 75%||24.2%||Pass|
|Total score||8 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With a score of eight, General Dynamics delivers nearly everything that conservative investors like to see in a stock. The defense contractor has seen a bumpy ride for its shares recently, but steady growth in sales and free cash flow has helped the company deliver consistent dividend increases.
Overall, investors have been down on defense stocks for quite a while. Many analysts are convinced that budget woes will require the federal government to slash defense spending, hurting General Dynamics and its peers.
Yet two things argue toward taking a closer look. First, shares of many defense stocks are extremely cheap. Along with General Dynamics, L-3 Communications (NYSE: LLL ) and Northrop Grumman (NYSE: NOC ) both have very attractive valuations, with normalized P/Es of 12 or less.
Second, backlog levels across the industry remain healthy. General Dynamics led the way with double-digit percentage backlog growth, but Northrop, Raytheon (NYSE: RTN ) , and ITT (NYSE: ITT ) were among peers also seeing substantial increases in backlogs.
If defense outlays do in fact fall, then defense will become a much more competitive industry. But even retirees and other conservative investors can feel comfortable about the margin of safety they have in General Dynamics shares. With a rock-bottom payout ratio, the company will be able to defend its dividend -- and that's exactly what retirement investors need to have right now.
Finding exactly the right stock to retire with is a tough task, but it's not impossible. Searching for the best candidates will help improve your investing skills, and teach you how to separate the right stocks from the risky ones.
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If you want to retire rich, you need to be confident that you've got the basics of your investment strategy down pat. See if you're on track by following the 13 Steps to Investing Foolishly.